Brace for Higher Rates

Interest rates are going up.

That’s what Eric Rosengren implied yesterday, and it’s a big part of the reason U.S. stocks and bonds sold off this morning, following a big drop in emerging markets overnight.

The President of the Federal Reserve Bank of Boston, Rosengren also sits on the Fed’s Open Market Committee, which effective sets short-term interest rates. His comments, made in a speech to a suburban Chamber of Commerce outside Boston, strongly suggest he’ll vote for an interest-rate hike when the FOMC meets on Sept. 20.

Rosengren’s words were: “A reasonable case can be made for continuing to pursue a gradual normalization of monetary policy.”

But make no mistake: that’s Fed-speak for “brace for higher rates.”

How do we do that?

First, by not doing anything drastic. As Personal Finance Chief Investment Strategist Jim Pearce has said, “The immediate Wall Street reaction will likely be negative, but in the overall scheme of things a bump in the Fed Funds rate from 0.50% to 0.75% is not going to change the way most investors evaluate their stock and bond portfolios.” That’s even truer of a 0.25% hike in any given month.

Second, by focusing on individual investments, not the overall market. If interest rates have bottomed, some sectors will likely perform better during the upcycle for rates – banking stocks, for instance. And in theory, some sectors will perform worse – like those that frequently borrow money for capital spending. But even in these areas, some companies will perform well and others poorly.

If stocks continue to sell off in reaction to the prospect of a rate hike, more and more bargains will emerge. High-quality companies that sell off? Sign me up. One great example is this mid-cap asset manager Ari Charney recently recommended.

Third, be rational. Market volatility is a reasonable expectation if rates start moving higher, not to mention the political uncertainty that accompanies a presidential election. But volatility can be your friend. It provides not only opportunities to buy new bargains, but to shift your own portfolio: on dips, you can add to your positions in attractive stocks; on spikes, you can sell stocks that no longer make sense.

What you don’t want to do is fall into the common trap of selling your winners too early. If the investment case for a stock made sense and still does, the fact that you enjoyed the early part of its run doesn’t necessarily mean you should sell. Some winners have more room on the upside, such as this one Joe Duarte recently re-recommended for subscribers of Breakthrough Tech Profits.

I still believe that the Fed will be reluctant to raise rates weeks before the election, but Rosengren, Fed Chair Janet Yellen and other Fed officials are starting to sound unanimous that we’ll see a hike sooner rather than later. So let’s be ready.

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